Economic challenges for Ukraine's new president

Today, Ukrainians will go to the polls to elect a new President. The billionaire businessman Petro Poroshenko has a strong lead in the opinion polls.

The chocolate tycoon and ex-foreign minister sees the country's future in Europe but with pragmatic relations with Russia.

For the last two decades, the EU and Ukraine have formed agreement after agreement on closer economic and political cooperation.

These include the Partnership and Cooperation Agreement in 1994, a joint EU-Ukraine Action Plan in 2005 following the Orange Revolution a year earlier, the Eastern Partnership in 2009, and most recently the EU-Ukraine Association Agreement in 2012.

Membership criteria

However, while the EU has been enthusiastic on the principle of Ukraine joining the club, no date for accession has ever been muttered.

The EU see three main impediments.

First, there are political issues including respect for the rule of law and stamping down on corruption.

Second, the flirtation with the Customs Union of Russia, Belarus, and Kazakhstan.

And third, Ukraine's poorly performing economy.

The new Ukrainian president will have to deal with an economy that has been in recession since the middle of 2012 and a budget deficit that has spiralled out of control to an unaffordable 12% of GDP.

Bailout conditions

Needing to find $35bn to pay its bills for the next two years, Ukraine was forced to accept an IMF bailout at the end of April.

The $17bn pledged by the IMF unlocked a further $15bn in funding from the World Bank, EU and other individual countries and will avert the immediate risk of default which I have written about before.

However, it has come at the price of accepting an austerity programme to cut the deficit.

Wage and pension increases promised by the previous government are now deemed unaffordable and have been cancelled. The minimum wage has also been frozen.

A new procurement law will rein back on government spending and there will be cuts in the public sector workforce. As many as 10% of civil servants could be made redundant.

The state-owned energy company Naftogaz has racked up huge losses by selling gas at a fraction of the imported price. Energy subsidies cost the government about 7.5% of GDP each year.

The IMF wants Naftogaz to break even in the next five years and gas prices were immediately increased by 50% as a condition of the bailout.

Gas prices were already rising as Russia had been giving Ukraine a one-third discount in return for leasing the naval base at Sevastopol to host its Black Sea fleet.

Having annexed the Crimea, it no longer sees the need.

The Ukrainian currency, the hryvnia, has lost a quarter of its value since the start of the year and fallen to record lows against the US dollar. As a result, import prices are rising quickly.

Too optimistic

Taken together with the rising cost of energy, Ukrainians can expect the cost of living to become more expensive at a time when incomes are depressed.

The IMF predicts Ukraine's economy will contract by 5% this year, but with modest growth returning in 2015.

However, that may be too optimistic. With austerity measures expected to bite hard, a drop in exports to Russia and ongoing instability in the east of the country, the economy may not turn a corner.

Just two weeks after the IMF assessment, a report by the European Bank for Reconstruction and Development predicted a contraction of 7% this year and no growth at all next year.